The early 1990s witnessed trade tensions between the United States and Japan, even though the U.S. current account deficit stood at about 1% of GDP and Japan is a democracy. As our chart shows, the world is now trying to manage much larger imbalances, and two of the major surplus countries are not democracies. Resolving these imbalances may be more difficult because of the dependence on exports in China and Germany, the two leading surplus economies.
Many fear that China will not be willing to continue financing the growing deficits of rich countries, particularly that of the U.S. Throughout the crisis, China has continued to buy dollar assets, although its total reserves have leveled. China will have to choose between controlling its exchange rate or controlling its dollar purchases.
Government borrowing has increased sharply, but the fall in private borrowing by households and firms has been equally dramatic. Overall borrowing has not changed substantially. Will the government be able to reduce its borrowing when private borrowing resumes?
The collapse in U.S. trade associated with the current downturn far exceeds the fall in any other post-war recession. It tracks the fall in trade observed in the 1930s, though there are now signs of stabilization. So far this collapse has been driven by economic factors, such as the decline in demand and trade financing, but as the world economy contracts the risk of protectionism increases.
U.S. government borrowing has grown substantially since the start of the economic crisis. Many fear that this trend will diminish U.S. power relative to other countries, particularly large creditor countries such as China. But the sources of borrowing have changed as well. More of the financing is now coming from domestic rather than foreign sources. What role does the level and source of borrowing play in determining relative power?
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